Net Debt Doesn’t Mean What Matt Yglesias Thinks It Does

[O]n a net basis the United States of America does not have any public debt and perhaps never did.

The conventional way for debt scaremongers to measure the national debt is to compare gross public debt to GDP. But the normal way you measure the debt load of a business or a household is to ask for a net figure. Just because you have hundreds of thousands of dollars in mortgage debt doesn’t mean you’re a pauper. In fact it probably means you’re a rich person who owns an expensive house. It is of course possible to take out a large mortgage and then end up “underwater” because house prices decline, but it’s simply not the case that a large amount of gross debt is a sign of overextension. It’s typically a sign of prosperity and creditworthiness.

But “net debt” doesn’t mean the difference between assets and liabilities – that’s the definition of net assets. Because when liabilities are greater than assets, you are technically bankrupt. I doubt that anyone is reassured by the fact that the United States is not technically bankrupt – I should hope nobody thinks that we needn’t worry about public indebtedness until that happens.

“Net debt” on the other hand means liabilities minus current assets – assets that are either cash or readily convertible to cash. If Yglesias’s chart is labeled correctly – and I can’t see his underlying data, so I may simply be misinterpreting what he’s trying to show – then we’re looking at overall public assets versus public debt. Most public assets are certainly not readily convertible to cash. And the public debt is frequently quoted as a net debt figure – that is, debt minus short-term receivables, cash and other marketable securities – so I wouldn’t be entirely surprised if the red line is already a net debt figure. Without access to the underlying data and clear definitions thereof, I can’t be sure, but it certainly doesn’t look like a chart showing that the United States never had any net debt – and it couldn’t be, because the US did, and does, have net outstanding debt.

Yglesias disparages the debt-to-GDP ratio, but it’s a pretty good rough-and-ready tool for measuring fiscal health, because your GDP is your tax base, and you service your debt out of taxes. If interest rates are very low, you can service a higher debt more cheaply, but over the long term rates should have a close relationship to nominal GDP, so if you’re projecting very low rates for a very long time, you’re also probably forecasting very low nominal GDP for a very long time. Which would be another reason to worry about a high degree of indebtedness.

For a business or household, you’d also pay attention to leverage – that is to say, not merely how above water you are, but how close to the water line. If you own a house at 5% down, you have a more risky financial position than if you own a house at 25% down, regardless of the value of your house. If you’re a bank with only 3% true equity capital, you’re running a riskier bank than if you have 10% true equity capital. To a certain extent, this is true for countries as well; there’s generally no way for foreigners to foreclose if the value of national assets drops below net debt, but currency crises aren’t exactly a picnic either. In the context of banking, Yglesias understands the importance of leverage. Why, here, does he suggest that the only thing that really matters is whether you’re in the money or not?

Here’s what I see when I look at the chart: from 1850 to 1950, both public debt and the value of public assets grew at a much faster rate than the economy as a whole. Debt expanded rapidly in wartime (Civil War, World War II, War War I), and tended to contract (as a percent of GDP) thereafter. Since 1950, however, the value of public assets has been relatively more stable (rising modestly through 1970, then falling through 1990, then rising again to somewhat above the 1970 peak) while the public debt first dropped dramatically (by nearly 50% to 1970, measured as a percentage of GDP) and then shot back up to around its 1950 peak. We’re not yet as leveraged as we were after the Civil War or after World War II, but our “net national equity” is smaller than it was in any other period, and (if you extrapolate out) shrinking.

Piketty’s argument is (in part) that the 1970-2010 period is much more representative of what trends in wealthy countries are going to look like for the foreseeable future than was the period from 1900 to 1970. That’s a period in which public indebtedness was rising rapidly while public assets rose barely at all. Why that’s a basis for complacency, I have no idea.

This argument alone undermines the entire position that assets against debt means no debt —

I think there are two challenges.

The first you mention — no quick cash conversion if any at all.

The second is the cause of no turnover — I used to teach students to weigh debt against assets – but I realized the problem is that the assets are not public. And they are not all owned or controlled by US entities.

As long as the US has the capacity to raise enough taxes to service the debt, it can. And with one of the lowest effective tax rates in the developed world, the US is very far from the point where raising the tax rate is not feasible or would decrease revenue (the Laffer point)

Further, there is structural difference in the debt of finite life entities (like households or factories) and infinite life entities (like utilities and countries).

Finite life entities have only a certain number of years to raise revenue (your working lifespan in the case of a household, the time until your machinery becomes obsolete and breaks down permanently in a factory and so on) These entities have to pay their debts BEFORE they run out of revenue is x number of years.

Unlike those, utilities and countries do not have a lifespan: utilities will have customers for the foreseeable future. Hey they will have more customers as population grows. Hence, they can always service the debt, and is normally cheaper to finance the expansion of the utility (to connect more customers) with debt than with equity. Once these customers are connected they will be there forever in most cases (title of the house might change, but there will always be a customer in that address). Utilities NEVER pay their debts, they just roll it over in perpetuity.

Likewise, countries have a sweet spot of debt vis-a-vis population and GDP and will tend to remain there. AS population and GDP grow, the country will raise debt to finance the new services the additional taxpayers require. And like in utilities, that debt is not supposed to be paid ever

J_A: I agree with everything you say, and I believe everything you say is entirely consistent with my post.

The whole reason that debt-to-GDP is a pretty good rough-and-ready way to assess creditworthiness is that the tax base is the true “asset” a country has, not the value of public assets as such, because a country services its debt out of taxes. I believe there’s a paragraph making that point halfway through my post. Yglesias was the one arguing that debt-to-GDP is irrelevant because the US has plenty of public assets to cover the debt principal.

Who are you arguing with? Perhaps you are agreeing with me, and arguing with Yglesias?

I agree with Noah that Yglesias’ logic is flawed on the public assets off-setting debt. And another point, while many public assets like roads and bridges may help the private economy, other public assets like buildings, military equipment, and land represent a removal and/or exclusion of resources from the private economy. So high public assets may actually hurt the economy.

Unless I am missing something the total available tax assests is exactly the GDP or the (real) net GDP.

The GDP is approximately 15.4 trillion the national debt is approximately 18.5 trillion dollars.

Assuming you could tax a rate across the board and snatch all the available cash revenues you’d still be short roughly three trillion dollars.

Maybe these actualities are off, but assuming that merely a raise in taxes could resolve the matter of debt makes no sense to me.

More the unimaginable mechanisms to create a structure to pay the debt down over time. Before I bought that analysis i would need to see exactly your new tax schedual and the period of time said schedule would need to be in place to both sustain a standard of living citizens could tolerate before they start the blood letting.

In either case unless the available tax exceeds the debt — I am not sure why I should breath a sigh of relief.

In your attempt to correct Yglesias you’ve made a jarring and critical error yourself. Taken what you’ve written, I have a question: an underwater homeowner without sufficient other assets is “bankrupt”? Their net debts exceed their net assets, no?

It’s pretty clear to me that you’re wrong wrong. Bankrupt does not mean what you say it means. I believe the word you’re looking for is insolvent.

If you’re going to correct someone else, you should be much more careful yourself. And go ahead and update this article without the debt-mongering and misleading use of bankrupt.

And focusing on debt without accounting for assets remains a massive error, which Yglesias is pointing out. Or am I mislead to think that sensible businesses and homeowners use this whole asset vs. debt framework that Fix the Debt and others seem chronically incapable of mentioning?